Speeches by Richard W. FisherWashington, D.C. | May 14, 2007

The Dog That Does Not Bark but Packs a Big Bite: Services in the U.S. Economy Remarks before the U.S.–China
Business Council, the Coalition of Service Industries
and the American Council of Life Insurers

Peter Ustinov, the great actor,
used to chide the British foreign service by saying
he was “convinced there is a small room in the
attic of the Foreign Office where future diplomats are
taught to stammer.” We do not stammer at the Fed,
but we have been known to mumble on occasion. In most
central banks, there has traditionally been a premium
paid for being opaque.

Alas, obscurity is not our privilege
in the reality show that is today’s financial
world.

The conduct of monetary policy
is inherently a forward-looking exercise: The Fed sets
policy with the goal of holding future inflation at
a reasonable minimum while helping economic activity
and employment grow at maximum sustainable rates. To
do so, the Fed must consider both current and expected
inflation and growth. A certain degree of transparency
and clarity helps increasingly sophisticated business
and financial market operators manage risk. Mindful
that our actions and deeds condition the expectations
of risk takers, it makes sense for central bankers to
provide context for our decisions.

This evening, I would like to
give you a little perspective from my perch at the Dallas
Fed. I would like to talk, hopefully with nary a mumble
nor stammer, about the service sector and what I consider
the consequences of having services, rather than manufacturing,
as the driving force of our economy. These views are
my own and, I hasten to add, do not necessarily reflect
the views of my colleagues on the Federal Open Market
Committee.

First, let me give you some facts
to set the stage. America’s economy is a behemoth.
In 2005, the Dallas district of the Federal Reserve
System—all of Texas, 26 parishes in Louisiana
and 18 counties in New Mexico—produced 25 percent
more output than India in dollar terms. The Twelfth
District, headquartered in San Francisco and overseen
by my colleague Janet Yellen, produced more output than
all of China. The 140 million workers in the United
States produce over $13.2 trillion in economic output;
82 percent of those 140 million workers are employed
in the service sector, producing 70 percent of our GDP.

Over the decades, the inexorable
forces of capitalist evolution have shifted our economic
base from agriculture to manufacturing and now to services.
The iconic economist Joseph Schumpeter wrote that “stabilized
capitalism is a contradiction in terms.” The transformation
of the American economic landscape over time is testimony
to our ability to harness our innovative, educated and
entrepreneurial culture to master—rather than
be victimized by—the instability that is inherent
in capitalism. Since the first risk takers arrived on
the shores of Virginia and at Plymouth Rock, it has
been in our DNA to climb up the value-added ladder.
A little history:

Two hundred years ago, over 90 percent of the U.S.
workforce was in agriculture. By the end of the first
decade of the 20th century, that share had shrunk
to 37 percent of the workforce. Today, less than 1.5
percent of America’s labor pool works on farms
and ranches—yet we are producing an agricultural
abundance.

Two hundred years ago, 4 percent of our labor force
worked in industry, which includes manufacturing,
construction and mining. By 1900, the figure had grown
to 28 percent, on its way to peaking at around 38
percent in the 1950s and ’60s. Today, traditional
industry employs just 16 percent of our fellow workers—and
we’re producing more goods than ever.

Two hundred years ago, 4 percent of the workforce
was in services. The percentage of service workers
has steadily grown, reaching 26 percent in 1900, passing
50 percent in the 1950s and, as I mentioned earlier,
employing 82 percent of our workforce today.

Let me put these numbers in perspective
for you by contrasting them with China. Today, about
44 percent of China’s working population is still
in agriculture, compared with America’s 2 percent.
Employment in the Chinese industrial sector is 23 percent,
compared with our 16 percent. China’s service
sector employs a little bit more than 30 percent of
China’s laborers, compared with our 82 percent.
In other words, China’s labor distribution between
agriculture, industry and services is about the same
as ours was in 1900.

Since the demise of Mao, the Chinese
have made great strides in improving their education
system. They are producing graduates in prodigious quantities.
And yet they are a long way from having the quality
educational system needed to produce trained workers
capable of rivaling ours. Around 15 percent of China’s
population aged 25–65 has a high school degree,
compared with 85 percent in the United States. One of
every 20 Chinese in that age group has a college degree,
compared with one in three in the U.S. In China, 700
people out of every million are R&D researchers.
Here, that number is at least 6.5 times higher.

And in terms of wealth, it is
interesting to note that China’s real GDP per
capita is roughly 1/25th the size of ours, about the
same level as what the U.S. achieved over a century
ago.

Our per capita wealth has grown
as we’ve moved up the value-added ladder. Generally
speaking, our highest paying jobs are in services—engineers,
scientists, computer systems analysts, stock brokers,
professors, doctors, lawyers, dentists, CPAs, entertainers
and other service providers, to say nothing of the mega-compensation
paid to hedge fund managers and financial engineers.

Beginning in 1993, the average
wage for private services employees surpassed base industry
wages. By 1999, all nonretail services employees, even
public service employees like government workers and
teachers, were averaging more pay per hour than industrial
workers.

The destructive side of the process
of capitalism’s “creative destruction”
is evident in the numbers as old professions give way
to new, higher-paying ones. The number of U.S. farm
laborers decreased 20 percent between 1992 and 2002.
In the same 10-year time frame, employment of telephone
operators decreased 45 percent. That of sewing machine
operators decreased 50 percent between 1992 and 2002.
This is not ancient history; this all occurred within
a time frame that is fresh in the memory of everyone
in this room.

Yet within that same time frame—between
1992 and 2002—the number of architects grew 44
percent, legal assistants 66 percent and financial services
employees 78 percent. In fact, Internet-related job categories didn't even exist until the early 1990s. The creative side of creative
destruction has replaced lost jobs in declining sectors
with new ones in emerging sectors.

Since 1992, the goods-producing
sector has seen its share of nonfarm payrolls fall by
3.9 percentage points. However, the losses have been
more than offset by job gains in just three service
sectors—professional and business services, health
care, and leisure and hospitality.

Today, manufacturing employs one
of 10 U.S. workers, about the same number as the leisure
and hospitality sector. One in 20 works in construction—fewer
than in financial services. Nearly the same number of
people work in government as in the goods-producing
sector as a whole. In the past year, the number of manufacturing
jobs shrank by 1 percent. In contrast, employment grew
by around 3 percent in education, health care, and leisure
and hospitality and by over 5 percent in professional
services.

Here is a statistic that about
beats all: At the end of 2005, the U.S. auto and auto
parts manufacturing industry employed about 1.1 million
workers and added 0.8 percent of the value to our GDP.
The legal services sector employed nearly the same number,
but contributed 1.5 percent of the value added to GDP.
I will resist the temptation to make a lawyer joke because
this is no laughing matter to economists: The legal
services industry provides as many jobs as auto manufacturers
but contributes nearly twice the value-added to our
economic output.

I think you get the point: The
service sector, not autos and other forms of traditional
manufacturing, drives our economy. And will continue
doing so.

Looking forward, the Department
of Commerce projects that the fastest growing jobs between
now and 2014 will be among general managers, health
care workers, postsecondary teachers, retail salespeople,
customer service reps and other service providers. In
contrast, among the jobs with the greatest projected
decline will be textile plant workers, machine operators,
farmers and ranchers, meter readers, computer and telephone
operators, typists, couriers and, to the relief of all
families who like to sit down to supper undisturbed,
telemarketers and door-to-door salespeople.

The shift of jobs away from the
goods and lower-value-added service sectors to higher-end
services is not a new phenomenon. Indeed, it is part
of a longer term trend of employment moving to sectors
that produce for an increasingly wealthy country, meet
the health care needs of our aging population, and provide
U.S. employers with the highly trained and flexible
workers they need in a broader, more accessible global
economy brimming with unskilled labor.

As people get richer, they shift
their spending toward relatively more services. Evidence
can be found in the buying patterns of U.S. households,
in the historical timeline of the U.S. economy and in
nations around the world. For every dollar Americans
spend on goods, we spend $1.70 on services—roughly
a 60 percent mix in favor of services. In contrast,
China spends 58 percent of its consumption on goods
versus 42 percent on services. In even poorer India,
services represent just 37 percent of spending—the
reverse image of the U.S.

In 1979, I was a young member
of the U.S. delegation President Carter sent to China
to settle the claims left after Mao’s government
seized the railroad rolling stock we had lent Chiang
Kai-shek. President Nixon had normalized political relations
in the early 1970s, but it fell to President Carter
to normalize economic relations and finally raise the
flag at the U.S. Embassy.

So that we could begin to trade
with each other and get on with a normal relationship,
Treasury Secretary Michael Blumenthal was dispatched
to negotiate with Deng Xiaoping. I was Blumenthal’s
assistant, so I accompanied him to all his meetings
with the Chinese leader. I will never forget our first
meeting with Deng. He was electrifying. You may remember
he was a short fellow—barely 5 feet, if memory
serves—but he was a giant of a man with big dreams.
In our first meeting, he entered the room and cackled,
“Where are these big American capitalists I am
supposed to be so afraid of?”

He then laid out his vision of
driving China down “the capitalist road,”
a plan he did not proclaim publicly until later. Deng
told us then that he would unleash the Chinese genius
and focus it on development and modernization. To him,
when it came to ideologies, it didn’t “matter
whether it is a yellow cat or a black cat, as long as
it catches mice.”

We all know the Chinese have caught
economic mice in droves. Since 1979, China reports having
grown at better than 9.6 percent a year, adding up to
a better-than tenfold expansion of the economy to date.
China’s factories produced 200 room air conditioners
in 1978; today, they claim to make 79 million a year.
Back in the dark old days of rigid central planning,
the Chinese produced 679,000 tons of plastics; last
year, they were up to 25 million tons—37 times
as much. In 2003, China turned out 260 billion more
square feet of cloth than it did in 1978. Today’s
great building boom is occurring in China, where their
government reported 38 billion square feet of floor
space was under construction in 2005 for all kinds of
structures, compared with 5.7 billion square feet in
the United States.

As China grows—and clearly
its manufacturing sector is fueling a very fast growth
rate—we know its demand for services will increase
even faster. This is good news for U.S. services businesses,
because we are king of the global services providers,
with an impressive array of sophisticated and high-quality
products and services available for sale.

The size and wealth of our market
and our tradition of consumer sovereignty have created
the largest and most advanced service economy in the
world, a fact reflected in our trade balance. We have
consistently run a massive trade deficit—we have
done so since the ’70s. Few, however, realize
that we run a growing surplus in services trade. That
surplus topped $70 billion in 2006, trimming down our
overall trade deficit by over 8 percent. Perhaps more
important, the positive services gap has been getting
bigger.

The U.S. remains a major destination
for international travelers, so it should come as no
surprise that in the bookkeeping for our external account,
travel is the largest private service we export. Lately,
however, travel’s prominence in the statistics
has been challenged by other higher-value-added services.
Over the past decade, exports of travel, transportation
and tourism have grown by 2.9 percent per year. By contrast,
computer and information services and research and development
have been growing at a double-digit pace. Similar stories
abound. Our business services of accounting, auditing,
management and consulting—along with insurance,
finance and training—have increased mightily,
thanks to technological advances that have made those
services more tradable. With 16 percent of the world
population plugged into the Internet and 41 percent
using cell phones, many knowledge-based services can
today be sold across the oceans through cyberspace at
a fraction of traditional shipping costs.

America tends to export things
that are high on the value-added ladder and import from
lower down. In computer and information services, for
example, we export $5.4 billion and import $2.2 billion.
Dig deeper into the data and you will find that we largely
export the services of systems architects and designers,
while we import the services of basic programmers, who
are the foot soldiers of the information economy. In
services exports, as in manufacturing and agriculture,
we are constantly moving up the value-added ladder.

We export twice as much intellectual property as we
import. Our royalty and license fee income has been
growing at 8 percent a year since 1992. Our exports
of legal services have grown at 7 percent per year,
and they now total nearly five times our imports. Exports
of industrial engineering services have increased 18
percent per year since 1992, and we are now shipping
out 13 times as much as we are receiving.

Our exports of film and TV rentals
are 11 times greater than our imports. Of the 15 biggest-budget
Hollywood movies made as of 2006, eight of them would
have lost money if seen only in the U.S.—a total
of $458 million in losses among them. However, when
you include overseas sales, not only did all eight of
them make money, but as a group they netted nearly $1.1
billion after production costs.

When I was deputy U.S. trade representative,
the late, great Jack Valenti used to lobby me ferociously
to negotiate the opening of foreign markets to U.S.-made
films. His argument was as straight as Occam’s
razor: Without the globalization of movies, studios
would have had to scale back budgets, make smaller sets,
use cruder animation, not-so-special effects and not-so-talented
actors and actresses, and create otherwise less sophisticated
and entertaining movies. Opening other countries’
markets to our movies would mean bigger and better movies
for us to enjoy and more jobs created here at home.
Jack was spot on. He would not have been the least bit
surprised by the blockbuster revenues earned globally
by Spiderman 3 over the past 10 days.

Here is the point: Be it in movies
or industrial engineering design, in the service arena
we are hotter than Scarlett Johansson. In high-value-added
services, the United States holds a significant global
competitive advantage.

The ubiquitous iPod tells the
tale. Engraved on the back of my iPod are the words:
“Designed by Apple in California. Assembled in
China.” As we send our services out into the world,
send our designs to Chinese or Vietnamese or Mexican
factories—factories we played a role in designing,
by the way—or educate foreigners in our universities,
or build R&D centers in India or Estonia or Israel,
we are planting apple seeds all over the world. As long
as those seeds are allowed to germinate and sprout into
economic growth, the world will demand more of our value-added
services. And as long as we here at home foster good
economic conditions—including well-administered
monetary policy—that allow our entrepreneurs to
continue creating and selling services demanded globally,
we will continue to create American jobs and enhance
our prosperity.

I mention “well-administered
monetary policy” deliberately. Obviously, the
women and men who create and build our high-end economy
work best when they are undistracted by inflation or
other forms of economic turbulence. They can do their
job best when we do our job best by administering
monetary policy that underwrites sustainable noninflationary
growth.

The shift to a service economy,
however, has made the conduct of monetary policy both
more difficult and easier. Let me touch on the challenges
it poses for monetary policymakers.

The service sector is hard to
measure. Services are intangible. The data for measuring
the impact of services are more squishy than the relatively
straightforward accounting for output in agriculture
and the manufactured goods sector. To assess services,
we must rely on surveys and the good judgment of the
statisticians who interpret them.

There are sophisticated techniques
for conducting these surveys. Yet when it comes to services,
we cannot easily discern differences between quality
improvements and inflationary price increases. This
is less of an issue with goods, where we can more readily
identify quality changes such as improvements in durability
or serviceability. For example, improvements in automobiles
are measured through the introduction of seatbelts,
airbags and crash-worthy bumpers; the increased durability
of engine and suspension components; electronic enhancements
that improve fuel efficiency; better sound systems;
voice-activated navigation systems and so on.

But in services, quality improvements
are less clear. If your barber raises the price of a
haircut, is it because you are getting a better haircut,
or is it because the shop is passing on its increasing
costs, or is there some other factor at play? I’m
sure you’ve seen $15 haircuts at a strip-mall
barbershop, and you’ve at least heard of hundred-dollar
stylings offered by salons along Wisconsin Avenue. Four-hundred-dollar
haircuts have been reported—even on the heads
of Democrats. Presumably, there is a quality difference
between them, but we can’t measure it the way
we can with a ’67 Mustang and Ford’s 2007
model, or between the computing power of an old IBM
mainframe and a modern Dell laptop.

This isn’t rocket science—it’s
more challenging than that. In rocket science, the objective
is defined and the process involves applying established
mathematics. The value of services is less quantifiable,
less well defined, and requires considerable judgment
to distinguish between price changes resulting from
inflationary pressures versus differences in quality.

Take what I do for a living as
another example. Government agencies that measure employment
and economic activity classify central banking under
a broad category called “financial services—other.”
It is a service. We serve the public by distributing
cash and coin, maintaining an efficient payments system,
supervising banks and setting monetary policy—what
many might consider important functions. If we perform
our services well, the economy keeps on humming, creating
jobs and building wealth. If we fail, or just mess up
every now and then, our missteps send ripples through
the economy. Cash does not arrive at banks or checks
don’t clear, inflation gains momentum or employment
grows at a suboptimal rate. Yet I can’t point
to where our success shows up in GDP statistics. Nor
can I tell you how much more or less productive I am
versus my predecessors or counterparts.

Our inability to fully distinguish
between quality improvements and inflation in services
means that when we look at growth in nominal GDP, we
can’t be entirely sure how much results from the
gains in real output and how much is inflation.

That is one set of issues. And
there are others. In accounting for a knowledge-based
economy, for example, the very concept of investment
should be broader than the traditional focus on equipment
and structures. U.S. government statisticians have already
expanded the definition of business investment to include
software. Arguably, they should be looking at education
spending—which is the very foundation of our knowledge
economy—in the same way, instead of counting education
costs as a consumption expense.

The point is that in our efforts
to assess the speed limit and engine temperature of
the economy, we have plenty of gauges on our dashboard
that we can use for evaluating the manufacturing sector.
Yet we are deprived of similarly reliable gauges for
measuring capacity utilization and other dynamics of
the service sector. We spend a terrific amount of time
analyzing domestic manufacturing reports—think
of the media attention given to the Philadelphia Fed’s
manufacturing index or the Empire State Index or, if
you are astute, the Dallas Fed’s manufacturing
index for a district—forgive my Texas brag—that
produces more manufactured products than the areas covered
by either the Philadelphia or New York surveys. Manufacturing
data is so refined that I can tell you whether the plastic
we make is used for a bag, bottle, pipe, pillow or floor.
Yet, as our economy becomes ever more services-oriented,
relying on traditional, goods-focused indicators as
predictors of economic activity or inflection points
in the business cycle becomes more and more suspect.
As comparative advantages are redistributed by globalization,
the importance of foreign capacity measurements for
manufacturing increases. And the need for a services
capacity metric here at home becomes imperative. And
yet we—and this is a collective “we,”
encompassing the economics profession worldwide, not
just the Fed—have perfected neither.

Herein lies an opportunity for
enterprising analysts to rise to the challenge I’ve
just presented and profit from the development of new
data that can help alleviate the deficiencies in service-sector
metrics. Many—including our co-host this afternoon,
the Coalition of Service Industries—draw well-deserved
attention to our services sector, measuring its size,
growth, scope and composition to drive home the point
that the U.S. economy is services driven. While we can
slice and dice the data we have, we still don’t
have enough of it available to help us monitor trends
with the level of detail and timeliness we have for
our goods-producing sectors.

I’ll conclude by calling
your attention to another aspect of the growing importance
of services in the U.S. economy, a subtle, behind-the-scenes
contribution that services are making to the decoupling
of the overall economy from the manufacturing sector.

Allow me to draw your attention
to Arthur Conan Doyle’s mystery, “Silver
Blaze.” In that story, a Scotland Yard inspector
asks Sherlock Holmes, “Is there any point to which
you would wish to draw my attention?” Holmes replies,
“To the curious incident of the dog in the night-time.”
Puzzled, the inspector notes, “The dog did nothing
in the night-time.” “That was the curious
incident,” Holmes says. The dog did not bark.

A “curious incident”
happened in the U.S. economy during the 2001 downturn.
Factory output fell by almost as much during that recession
as in the 1981 recession 20 years earlier—7 percent
in 2001 versus 8 percent in 1981. Yet, GDP declined
by less than half a percentage point in the 2001 downturn
versus 3 percent in 1981. The mystery is why the aggregate
economy was so much less affected in 2001.

Undoubtedly, a significant part
of the explanation is the sharply declining and relatively
low real interest rates in the latter period, which
helped sustain the construction industry. But it is
also important to note the very different behavior of
the goods component of GDP across the two episodes.
In 1981, “total goods sector” output fell
by the same amount as factory output. In 2001, it fell
by only half the decline seen in manufacturing. To use
the Holmes analogy, goods output “barked”
loudly in 1981 in response to the collapse of manufacturing.
In 2001, goods output merely whimpered.

This curious incident points to
the solution to our mystery: What the Commerce Department
calls “goods-sector output” in fact includes
a growing retail and distribution services component
that is relatively insensitive to fluctuations in factory
production. This was the dog that did not bark. The
merchandising services component of goods-sector output
declined relatively little in 2001 and helped insulate
the economy from the manufacturing collapse.

The service sector may not be
as noisy or get as much analytical or political attention
as the manufacturing sector, but it has a significant
bite in terms of its impact on economic performance.
That is the point to which I hope to have drawn your
attention today. As we seek to conduct monetary policy,
we will have to develop new methods for determining
exactly how the service sector's bite affects the business
cycle and economic behavior.

Enough said. Thank you for listening.
Let’s stop there, and in the best interest of
being transparent, I will do my best to mumble and stammer
through responses to your questions.

About the Author

Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.

The views expressed by the author do not necessarily reflect official positions of the Federal Reserve System.